Thursday, 21 July 2016

The UK has a new government under the leadership of Theresa
May. The mandate of the new government, as the new prime minister stated, is to
"make a success of Brexit". Although the detail of what success here
means is unclear, there can be no doubt about what it means in general. It
should be interpreted as keeping access to the EU single market while gaining
concessions from the EU about the rights of the United Kingdom to control
immigration. In other words: trying to square the circle. Something the Brexit
campaigners have led millions of British citizens to believe can be done
easily.

What negotiation strategy should the European Union take? Here
is the choice that must be presented to the UK. Either the UK government takes
over the Norwegian model or it stands alone and negotiates new trade agreements
with the EU and about fifty other countries (or group of countries) in the
framework of the rules of the World Trade Organization (WTO). The EU must make
it clear that there is nothing between these two choices. There can be no
"special deal" with the United Kingdom.

If the UK accepts the Norwegian model, it retains full access
to the single market. In that case there are no obstacles for British goods and
services in the EU and for EU goods and services in the UK. But the price the
UK pays in this model is the free movement of EU citizens in and out of the UK.
Without the free movement of people there can be no free movement of services.
This is the core of the single market. Moreover, the Brits will have to accept two
other things in the Norwegian model. First, they will have to abide by the rules on
standards, health and safety that are decided in Brussels without being involved
in the decision making process. Secondly, they will have to contribute to the
European budget.

It is very unlikely that the UK government will accept this
model. The Brexit camp considers free migration and Brussels legislation as diabolic
and will revolt if the UK government accepts these conditions. True there is an
important faction in the new government that is attached to maintaining full
access to the single market and sees few problems in accepting free movement of
people and Brussels regulation. But this faction is probably too weak to
counter the demands of Brexit
supporters.

I assume, therefore, that the British government will reject
the Norwegian model and will try to obtain concessions from the EU that reduce
migration flows, while ensuring access to the single market. Here, the EU must
make it clear that a special deal with the UK is excluded. The EU must insist
that the only other option for the UK is to stand on its own feet, and to start
negotiating new trade deals with the EU and other countries after Brexit is
completed. In other words, the UK must be treated like the US, China, Brazil,
etc., i.e. as sovereign nations that insist on maintaining full sovereignty over
their trade agreements. The trade negotiations between the UK and the rest will
take years, if not decades. Their outcome is uncertain. It is not clear, for
example whether the UK will be able to maintain free movement of services with
the EU as this freedom is intimately linked to the free movement of people. But
that is a problem for the Brits who have chosen to embrace full sovereignty.

Here are the reasons why the EU should not accept to be
dragged down in negotiating a special deal with the UK. Some EU-countries are
tempted today to also organize referenda. I have no problem in principle
against such referenda. If citizens of a country dislike being member of a
club, they should be able to leave. This will be better for all. There is no
point in living together with people who intensely dislike each other. However,
it is in the interest of both parties that the terms of the divorce should be
made clear in advance.

That is why the EU should make it clear what potential exiters
should expect. It will be either the Norwegian model or a “standalone-model” in
which the newly sovereign nations will face the difficult task of establishing
new trade agreements on their own. Clarity is essential for those who consider
leaving the EU. This clarity can only be achieved by excluding a privileged
trade agreement with the United Kingdom.

When the UK joined the EU in 1973 its main strategy was to
prevent the union from becoming too strong. The UK political elite decided that
this could best be achieved from inside the union. Now that the UK is departing
the century old British strategy remains the same, i.e. to weaken the forces
that can make Europe stronger. The UK can achieve this by insisting on a
special deal between the UK and the EU whereby the UK maintains the benefits of
the union while not sharing in the costs. Such a deal, if it comes about, will
signal to other member countries that by exiting they can continue to enjoy the
benefits of the union without the costs. Such a prospect would fatally weaken
the European Union.

Friday, 1 July 2016

How should the European Union react to the decision of the
British people to withdraw from the union? This is the question that is at the
center of the political debate in Europe.

The starting point in trying to answer this question is the
observation that the European Union has a very negative image today, not only
in the UK but also in other parts of the EU, leading to dissatisfaction about
the European project. I will argue that this dissatisfaction has to do with the
inability of the European Union to set up a mechanism that protects the losers
of globalization. Worse, the EU has reduced the capacity of national
governments to take on the role of protector, while little has been done to
create such a mechanism at the EU-level.

Free trade creates an incredible dynamic of innovation and
material prosperity. That prosperity, however, does not benefit everyone. Many are
better off thanks to globalization. But many others are not. Some even see
their welfare decline because they lose their jobs or because their incomes
fall.

As globalization creates material welfare in the countries
that participate in it, it is in principle possible to compensate the losers
from globalization. That is the argument that most economists find strong
enough to defend globalization. But the political obstacles against organizing redistribution
towards the losers of globalization are large. This is a problem in most
industrialized countries, but it is made even more intense in the EU.

The European institutions have become major promoters of
globalization. The single market and the trade agreements reached by the
European Commission have widely opened up the European gates to globalization. There
is nothing wrong with that per se. Except that there is a complete failure to
organize the necessary compensation towards the losers of the globalization.
The European institutions have no power over social policy, which has been kept
in the hands of the national authorities. However, the hands of these
authorities have been shackled by the same European institutions’ fiscal rules.

The European fiscal rules not only make it extremely difficult
to compensate the losers from globalization. What is worse, they have amplified
the hardship of the losers from globalization. Since at least five years the
European Commission has pushed all member-countries of the Eurozone into an
austerity straightjacket that has produced economic stagnation and rising
unemployment mainly of those who had already been hit badly by globalization. It
will be no surprise that many turn their backs towards the European
institutions that are seen as cold and ready to punish when millions live in
hardship.

Not only the fiscal rules but also the structural reforms that
have been imposed by the same European institutions are to blame for the
rejection of the European Union by millions of people. European policy makers have adopted the
neo-liberal discourse. According to this discourse, workers must be flexible
(read: they should be happy when their wages fall, when they can be dismissed
quickly and when they receive less unemployment benefits). The neo-liberal
policymakers that now dominate the European Union preach that social security
is unproductive and should be downsized. These policies are euphemistically
called structural reforms. They are imposed on millions of people, mostly the
losers of globalization, by European institutions and national governments
alike.

The problem of the European Union today is that, instead of
helping those who suffer from globalization, it has set up policies that hurt
these people even more. It is no surprise that the losers revolt. If the EU
continues with austerity and structural reforms, revolt will spread and will
take the form of attempts to exit the Union. It is time the European Union
takes the side of the losers of globalization instead of pushing for policies
that mainly benefit the winners.

This can be done in two ways. The first one is to stop
imposing structural reforms on the member-states. The rationale for these
structural reforms has been that they promote economic growth and therefore
should benefit everybody. The empirical evidence of a positive link between
structural reforms and economic growth, however, is very weak. Recent
econometric analysis of the OECD countries fails to find evidence that reforms
in the labour markets and in the product markets boost economic growth (De
Grauwe and Ji(2016), IMF(2015)). These studies, however, find that investment,
both private and public, has a strong positive effect on economic growth.

The latter result points the way to the second change in
economic policies that the European policymakers should initiate. This should
consist in boosting public investment. The latter have suffered severe
collateral damage from the ill-conceived austerity programs imposed by the
European institutions.

A boost in public investment can only be achieved by changing
the fiscal compact that imposes structural budget balance in the member-states
of the Eurozone. This compact has the unfortunate implication that public investment
can only be financed by current revenues. A more destructive rule for economic
growth has rarely been imposed.When
politicians are told that the cost of public investment should be fully borne
by present taxpayers (voters) while the benefits will accrue to future
taxpayers (voters) it will not surprise that the political incentives to engage
in public investment will be weak. This is what happens today. Thanks to an
ill-conceived rule, public investment in the Eurozone is at a historic low
level.

It is often said that allowing public debt to increase will
saddle our children with an unbearable debt burden. This criticism confuses
gross and net debt. When productive public investments are undertaken by
issuing government bonds, our children will inherit both productive assets and
government bonds. Today the cost of issuing government bonds is close to zero
in many Eurozone countries. If governments manage to invest in productive
assets that have a return higher than zero, our children will inherit assets
that create revenues exceeding the cost of borrowing. As a result, their net
debt burden will have declined. They will not understand why we have not increased public investment when borrowing was so cheap.

I am a proponent of more political integration in Europe. But
today grand schemes for “more Europe” should be put on the back burner. Instead
European politicians should change their economic policies and, in so doing,
show in the facts that the European Union can produce welfare, also for the
losers of globalization.

References:

De Grauwe, P. and Ji, Y., (2016), Crisis Management and
Economic Growth in the Eurozone, Chapter 2, in Francesco Caselli, (ed), Prospects
for Growth in the European Union, Oxford University Press.

IMF World Economic Outlook, (2015), Ch. 3, Box 3.5 on The Effects of
Structural Reforms on Total Factor Productivity, 104–7.